can the oil cartel raise prices by cutting back production

That’s the rumor that has been supporting the oil price over the past week or so, despite this being the weakest season of the year for petroleum demand. The story is that OPEC and Russia are having discussions right now about withholding output from the market in order to push prices up.

How likely is this to happen?

How likely is it that prices will rise if OPEC and others take action?

Supply/demand data

–world oil demand is about 95 million barrels a day, according to the International Energy Agency. That figure has been growing at about a 1.5 million daily barrel clip over the past few years. The IEA forecasts growth in demand to drop to a gain of 1.2 million in 2016, due to economic slowdown in China and the EU. But demand will still likely be 96 million barrels/day by December.

–world oil supply is about 97 million barrels daily, according to the IEA. That’s about 3 million barrels higher than at the end of 2014, due to increases in output from the US (2 million), Iraq (1 million) and Saudi Arabia (1 million-), partly offset by a bunch of production declines elsewhere.

–of the 97 million barrels of output, 39 million come from OPEC and about 14 from the former Soviet Union (11 million from Russia). The rest come from oil consuming areas like the US, the EU and China. These producers are, in my view, highly unlikely to cut output except when the selling price falls below the out-of-pocket costs of getting oil to the surface.

What I find fascinating about oil–and maybe this is just me–is the figures above show the gigantic fall in price since mid-2014 has been caused by a difference between supply and demand of only about 2%. In fact, the IEA is forecasting continuing downward pressure on the oil price even though it thinks that the excess supply will be reduced to about 300,000 barrels daily, about 0.3%, by yearend.

It’s also important to note that demand for oil is relatively insensitive to changes in price over periods of a year or two or three. Greater fuel efficiency of cars, substitution of natural gas or alternative energy, better insulation against heat and cold in construction, high taxes on fossil fuels in most developed countries (ex the US), are among the reasons. What’s key for this discussion is that higher prices are very unlikely to make a dent in demand. That’s a strong reason in favor of cartel action.

So, what would OPEC + Russia have to do to create a supply deficit?

…remove 2 million barrels of oil daily from world supply. Let’s say 3 million, just to be on the safe side. Given that OPEC + R control output of 53 million, that would mean each member reducing production by about 6%. Assuming that increasing supply from US shale oil would only become economic at $40 a barrel, implying that’s the highest sustainable level prices are likely to achieve, OPEC + R could reap an almost immediate 25% increase in revenue by trimming output by 6%. That’s a powerful incentive for economies radically dependent on oil sales and running short of cash.